The average household with credit card debt had a balance of $16,748 in 2016, nearly passing the peak of $16,900 in 2008 according to NerdWallet. According to CreditCards.com, the average credit card annual percentage rate is sitting at 15.8% as of May 17, 2017, which represents an expensive way to fund spending! This leads us to a question that many individuals as us on a daily basis, “Should I borrow from my 401k to pay off debt or to make a major purchase?”
It’s important to understand that distributions from 401k plans and most other employer-sponsored retirement plans are taxed as ordinary income and, if taken before age 59.5, may be subject to a 10% federal income tax penalty. Generally, once you reach age 70.5, you must begin taking required minimum distributions.
Borrowing from Your 401k
- No Credit Check
If you have trouble getting credit, borrowing from a 401k requires no credit check; so as long as your401k permits loans, you should be able to borrow.
- More Convenient
Borrowing from your 401k usually requires less paperwork and is quicker than the alternative.
- Competitive Interest Rates
While the rate you pay depends upon the terms your 401k sets out, the rate is typically lower than the rate you will pay on personal loans or through a credit card. Plus, the interest you pay will be to yourself rather than to a finance company.
Disadvantages of 401k Loans
- Opportunity Cost
The money you borrow will not benefit from the potentially higher returns of your 401k investments. Additionally, many people who take loans also stop contributing. This means the further loss of potential earnings and any matching contributions.
- Risk of Job Loss
A 401k loan not paid is deemed a distribution, subject to income taxes and a 10% penalty tax if you are under age 59½. Should you switch jobs or get laid off, your 401k loan becomes immediately due. If you do not have the cash to pay the balance, it will have tax consequences.
- Red Flag Alert
Borrowing from retirement savings to fund current expenditures could be a red flag. It may be a sign of overspending. You may save money by paying off your high-interest credit-card balances, but if these balances get run up again, you will have done yourself more harm.
Most financial professionals may caution against borrowing from your 401k, but they also agree that a loan may be a more appropriate alternative to an outright distribution, if you absolutely need the funds. Take a few moments to schedule an appointment with us, and we will be glad to review your situation and help you make the best beneficial decision. As one of the top financial advisors in Harrisburg, PA, we take commitment to you as our personal client very seriously.